Friday, October 30, 2015

Canadian Tax Primer 14: General Rules for the Capital Gains Exemption

Each individual resident in Canada can claim a lifetime capital gains exemption.  This means tax-free capital gains on the sale of qualifying assets.

Two separate limits apply.  An individual can claim up to $813,600 (in 2015) in exempt capital gains on the sale of shares of an active business corporation.  If the sale involves specified types of farming or fishing property, the exemption limit is $1 million per Canadian-resident individual.

Even though there are two separate limits, the limits are cumulative over one’s lifetime.  If you claim the exemption on one type of asset, that claim reduces your exemption room on the other type of asset.  For example, assume that you have previously claimed $300,000 in exempt capital gains on the sale of shares of an active business corporation.  This means that you have $513,600 of remaining exemption room if you sell more active business corporation shares (the $813,600 cumulative limit less the $300,000 previously claimed) or $700,000 of remaining exemption room if you sell qualified farming or fishing assets (the $1 million cumulative limit less the $300,000 previously claimed).  You cannot claim both $536,000 on the sale of shares plus $700,000 on the sale of farming or fishing assets.

Just to be clear, these exemption limits refer to the whole capital gain (not the half of the capital gain that is included in income).  Tax Primer 5 explains that only half of a capital gain is subject to income tax, but ignore that rule for this discussion.

The exemption limit for active business corporation shares is linked to the inflation rate, so new exemption room is added each year.  The exemption limit for farming and fishing assets is fixed at $1 million until the limit for active business corporation shares also reaches $1 million (as a result of inflation).  Once that point is reached, both exemption limits will thenceforth march into the future arm-in-arm, both linked to inflation.

Various rules affect a person’s ability to claim the capital gains exemption.  For example, access to the exemption may be restricted if you have a positive balance in your CNIL account.  The tax acronym CNIL is pronounced “senile”; however, we are told that it has nothing to do with the government’s opinion of the average taxpayer.  Instead, it stands for “Cumulative Net Investment Loss”.  A “Cumulative Net Investment Loss” arises if certain investment expenses deducted after 1987 exceed certain types of investment income reported after 1987.  You might have a “CNIL” problem if you have invested in certain types of tax shelters.

If you have previously incurred allowable business investment losses (referred to as ABIL’s in tax shorthand), you will have to pay tax on capital gains until you have “paid back” the tax relief provided by those losses.  Once that is done, you can start to apply your capital gains exemption against any remaining capital gains.

A capital gains exemption claim can also trigger federal minimum tax.  This is a timing consideration.  The government wants you to be successful, but not too successful in any one year.  If the exemption claim saves too much tax, you may have to defer part of the tax savings to a future taxation year.  Usually, however, this amounts to no more than a mild irritation in the long run.
Only Canadian-resident individuals can claim the capital gains exemption.  This can cause confusion in connection with the sale of active business corporation shares.  An individual has to sell shares of an active business corporation in order for the exemption to be available.  If the individual sells assets of an unincorporated business, however, the individual cannot claim the exemption.  So it may be necessary to incorporate the business before selling the business.

While it may be necessary for the business to be incorporated before an individual can claim the exemption, a corporation itself cannot claim the exemption.  So it is important to ensure that the business is incorporated but that individuals own the shares of the corporation that carries on the business.

While only Canadian-resident individuals can claim the capital gains exemption, each Canadian-resident individual can claim an exemption.  If you have an incorporated family business, therefore, you might want ownership of that business to be structured so that each family member can claim a capital gains exemption on a future sale of the shares of that incorporated business.  I will discuss this in more detail in Tax Primer 15.  Stay tuned!


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for information about our services and lawyers' profiles.

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.

Wednesday, October 14, 2015

Canadian Tax Primer 13: The Family Home

For many Canadians, the family home is a major asset.

In tax parlance, the family home is called the “principal residence”.  In general, any increase in value on a principal residence is not subject to capital gains tax.  This rule applies whether the capital gain arises as a result of an actual or a deemed disposition.

As with any tax exemption, some rules have to be kept in mind.  In general, a family unit can have only one principal residence at a time.  A family unit consists of a mother, a father and their unmarried children under the age of 18.

If you and your spouse have a house and a cottage, only one of the properties can qualify as a principal residence.  You can choose which of the properties to claim as your principal residence.  In most cases, you will want to select the property with the largest increase in value.  However, the capital gain on the property you do not select as your principal residence will be subject to tax. 

The one-principal-residence-per-family restriction creates a significant tax disadvantage if you place title to your home in the joint names of yourself and your adult child (assuming that the child also owns a home).  In that case, the child will have two residences:  an interest in the child’s own home and a 1/2 interest in your home.  Only one of those properties will qualify as the principal residence of the child.  The likely result is that 1/2 of any increase in value on your home will become subject to capital gains tax at some point down the road.  If you had retained sole ownership of your home, the entire capital gain would be immune from tax up to the date of your death.

The above discussion assumes that the principal residence has always been used as a personal home.  A part of the capital gain may be subject to tax if the house has been used for other purposes.  For example, you may have rented the house to tenants at some point in the past.  In this case, a pro-rata portion of the increase in value may be subject to tax.  However, the rules on this point are fairly complex.

The principal residence exemption applies only for income tax purposes.  The value of the house may still be subject to probate taxes on death.  As well, various provinces impose transfer taxes on the transfer of real estate.  Whether a transfer tax applies on the transfer of a principal residence to a related person depends on the province in question.


Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.